Taking Stock

So it’s come to this. Are you a bona fide merchant or just another retailer whose primary focus lies in seeking to maximize profits each and every quarter? Those lines are a lot blurrier than they have ever been and that’s great news for private equity firms who are back big-time in the supermarket acquisition business.

Actually, it’s pretty easy to separate the true merchants (be they publicly-traded corporate chains, privately-owned regional retailers or local independents), who are aggressively trying to move more boxes and whose vibe is clearly evident once one enters their stores (Wegmans, Kroger/Harris Teeter, ShopRite, Whole Foods, Eddie’s of Roland Park and Trader Joe’s) from the earnings chasers, who clearly care more about meeting quarterly guidance expectations than they do in how their stores are viewed by their current customers when judging such critical touch points as training, staffing, pricing, private label perception and overall shopping experience. Of course, there’s the “all other” category which consists of companies that seem somewhat clueless (Delhaize America, A&P) or are organizations that are attempting to dig themselves out of such deep holes that their current grade reads “incomplete” (Supervalu).

I recognize that we’re not living in North Korea and that profits are a good thing. Only not as good as when those profits are achieved at the expense of selling more cases (and units) with secondary regard to what’s rung up at the register.

And that again leads me back to my main point – if you’re in the private equity/venture capital business, mediocrity or decline is good when evaluating a potential retailer to target. And right now, business is very good in the PE world with even greater promise on the horizon.

After a lull of about a decade, private equity, led by Cerberus Capital Management, has been on a tear over the last 18 months. During that period, Cerberus and its subsidiaries have acquired or taken control of Supervalu (including its former Albertsons stores which were spun off into a separate unit) and United Family Markets. Cerberus also came in second place in the Harris Teeter auction and is reportedly hot to trot to acquire Safeway. During that same period Dallas, TX-based Lone Star Funds (and its affiliates) acquired Winn-Dixie and combined it with Bi-Lo (which it acquired in 2005) to form a solid base in the Carolinas and Florida (it also acquired 165 Sweetbay, Harveys and Reid’s units from Delhaize America to bolster its presence in Florida, Georgia and South Carolina). Other active PE players in the supermarket division are Yucaipa Cos. (which owns A&P and is currently on the trail of Tesco’s Fresh & Easy stores on the West Coast) and Empire Cos., which recently acquired Safeway’s 233 store Canadian operation.

Expect the trend to continue. Why? Because private equity is currently looking at a “perfect storm” scenario. With very deep pockets and a resurgent debt market, supermarkets are a prime targets because of the real estate they own or control, the large amount of cash they generate and the general undervaluation of the companies’ stock price.

And while one could argue that private equity’s ownership has created improvements at the companies they purchased, none of these PE-driven deals has resulted in transforming any of these retailers into honor roll performers. Then again, when your modus operandi is to squeeze out the assets, manage the overhead tightly, treat cap-ex conservatively and then ultimately flip the investment, how can greatness ever be expected?

Of all the recent supermarket deals consummated, only Kroger’s acquisition of Harris Teeter (which is not yet finalized) was executed by a strategic player whose share price was already well above the industry norm and whose management consistently focused more on the top line than the bottom one.

So, what do Winn-Dixie, Supervalu, New Albertsons and A&P have in common? Their performance grades were “C” or lower, but they all possessed the qualities that PE desires: real estate, cash flow and disappointing stock price.

And while Safeway’s performance is above those other PE-acquired chains, the Pleasanton, CA operator possesses many of these same core attributes. And because of the obsessiveness to eliminate waste by former CEO Steve Burd, Safeway is very streamlined to become somewhat of a turnkey operation for a prospective financial buyer.

I’ve said this many times before: when a company hires a Wall Street firm (Goldman Sachs) for advice or to explore its future options, that company is as good as sold. In Safeway’s case, I wouldn’t make book on it, although I’d still make a decent sized wager that it will happen. Shareholders have been disappointed with Safeway’s performance for several years and new CEO Robert Edwards seems all about maximizing shareholder value (a sale of the company or even rumors of a sale are a good catalyst to lift share price).

For Safeway, it doesn’t seem like there’s a strategic buyer interested, but there may be more than just Cerberus bidding among PE firms.

While it’s not always an indicator of final destination, it should be noted that a number of key Safeway executives have sold significant blocks of stock in the past six weeks since Jana Partners amassed its 6.2 percent stake and the Cerberus speculation arose. President Robert Edwards sold 273,000 shares (a cash out of nearly $9.1 million); executive VP-marketing Diane Dietz sold almost 300,000 shares of Safeway stock (worth about $10.5 million); and executive VP-human resources Laree Renda sold 50,000 shares (valued at approximately $1.8 million).

There’s nothing illegal or immoral with company executives reaping the rewards of their hard-fought efforts. On the other hand, doesn’t it make you think that they believe that initial private equity interest may serve as the catalyst for bigger things to come?

There’s definitely smoke here. It won’t take too long to recognize whether there’ll be fire, too. Not only at Safeway, but at other retailers that possess the formula that the newly emboldened private equity firms desire.